Dealership market: Market-making with inventory

This study considers the problem of a price-setting monopolistic market-maker in a dealership market where the stochastic demand and supply are depicted by price-dependent Poisson processes [following Garman (1976)]. The crux of the analysis is the dependence of the bid-ask prices on the market-maker's stock inventory position. We derive the optimal policy and its characteristics and compare it to Garman's. The results are shown to be consistent with some conjectures and observed phenomena, like the existence of a ‘preferred’ inventory position and the downward monotonicity of the bid-ask prices. For linear demand and supply functions we derive the behavior of the bid-ask spread and show that the transaction-to-transaction price behavior is intertemporally dependent. However, we prove that it is impossible to make a profit on this price dependence by trading against the market-maker. Thus, in this situation, serially dependent price-changes are consistent with the market efficiency hypothesis.     

Intertemporally Dependent Preferences and the Welfare Cost of Capital Income Taxation

The welfare cost of capital income taxation is analyzed utilizing intertemporally dependent preference operationalized using a variable rate of time preference. It is shown that if households exhibit increasing marginal impatience, then the welfare cost of capital income taxation is inversely related to the elasticity of the rate of time preference with respect to consumption. Therefore, the welfare cost of capital income taxation reported using time additive preferences may not be robust. Numerical examples show that the use of time additive preferences could result in the welfare cost of capital income taxation to be overestimated by as much as 25%.     

Monetary randomness and investment

This paper develops a neoclassical model in which the behavior of the money supply affects investment by affecting the real distribution of asset returns. Investment depends on wealthholders' demand for capital. A stochastic money growth rule influences portfolio choice by affecting the distribution of the inflation rate. The variance of inflation matters to wealthholders because of the existence of assets with returns that are not indexed to changes in the price level: money and bonds which are contracted in nominal terms. In a rational expectations environment, asset demands will thus be sensitive to the distribution of the money growth rate. Our principle conclusion is that an increase in the variance of the money growth rate lowers investment, which complements Tobin's (1965) result that an increase in the mean stimulates capital accumulation. The paper also represents a step toward incorporating an asset market into a macroeconomic model in a manner which takes account of Lucas' (1976) criticism of econometric policy evaluation. All variables in the model, including asset return distributions, are functions of technology, preferences and the money supply rule. Further, expectations are rational.     

The effect of uncertain inflation on firm value in a multiperiod economy

We model firm value in a multiperiod setting with uncertain inflation and show that real rates of return on the firm's securities are intertemporally dependent. The model also predicts an inverse intertemporal relationship between the real rate of return and the lagged value of Tobin'sq. We report empirical evidence in support of the hypothesized relationship. The model could explain the mean-reverting property of long-horizon stock returns reported in recent studies.     

Taxes,transactions costs and the clientele effect of dividends

This paper is an empirical investigation into the extent to which transactions costs and taxes influence individual investors' portfolios. Using actual portfolio and demoraphic data made available by the Individual Investor Research Project at Purdue University, this study finds evidence of a significant dividend clientele effect. Reasonable proxy variables used to measure time preferences and tax rates in part explain the cross sectional variability of investors' portfolio dividend yields. The variables that are most important in influencing the individual's dividend decision are age, and a measure of the investor's differential tax rate on dividends and capital gains.     

The consumption based asset pricing model: A note on potential tests and applications

Breeden's demonstration that Merton's multi-beta capital asset pricing model can be collapsed into a single-beta model where betas are computed with respect to aggregate consumption is an important theoretical advance. Nonetheless, Breeden's model retains many of the empirical problems that beset Merton's earlier version. In general the consumption betas will be nonstationary, so that the state variables must be observable for the model to be estimated.     

Motivating managers to make investment decisions

Owners of capital frequently lack knowledge about investment opportunities. One alternative is to turn to a manager for assistance. The owner's problem of contracting for the services of a manager is treated as a problem in buying information. The surprising result is that it is sometimes possible to trade information even when the owner is unable to form his own assessment of the information's value. Under some conditions it is possible to write a managerial compensation contract which will induce the manager to act in the best interests of the owner. These conditions require owner knowledge of the manager's employment and investment alternatives and risk preferences as well as some, but not all, of the characteristics of the investment opportunities.     

Using linear and goal programming to immunize bond portfolios

Bierwag and Khang's (1979) model of immunizing a portfolio of default-free government bonds is expanded here to include default-grade corporate bonds. The immunizing equation is found to be slightly different. Both linear and goal programming are shown to be alternative techniques for identifying an investor's optimal immunizing portfolio.     

Dynamic behavior of capital accumulation in a cash-in-advance model

This paper analyzes the dynamic behavior of capital accumulation in Stockman's cash-in-advance model. If the cash-in-advance constraint applies only to consumption, then money is superneutral along the transition path as well as in the long run. Alternatively, if the cash-in-advance constraint applies to gross investment as well as consumption, then a permanent increase in the rate of monetary growth reduces the steady state capital stock. The effect on the speed of adjustment depends on the sign of a certain simple function of the parameters of preferences and technology.     

The demand for and supply of deposits by credit unions: The Caisses populaires' case

The aim of the study is to explain Quebec major credit union's deposit market by way of intergrating its public demand function with the institution's rate-setting operation. The demand for Caisses' deposits is specified as a dynamic stock adjustment model. On the other hand, the intermediary's rate-setting reduced form is derived from a risk-return portfolio balance model which the managers maximize the expected utility of reserves. The two models are integrated by means of a liability composite rate. Econometric estimates of the integrated model provide us with interesting policy insights. For instance, the Quebecois public views chartered banks' deposits as a weak substitute for Caisses' deposits; it is also more responsive to non-rate arguments, such as loan eligibility or the institution's ethnic appeal. On the supply side, competitive liability rates are more important than returns on assets when the Caisses set its deposit rate. Finally, the impact growth imbalance between loans and deposits is well captured by a flow variable, without infringing on the steady-state determination based on rates.     

Hedging, hedge accounting, and speculation in a rational expectations equilibrium

This paper explains corporate hedging and speculation in a two period rational expectations model. A risk averse manager represents a firm that is priced in a risk neutral market. The manager enters into a cash flow hedge of a forecast transaction by taking a short position in the futures market. When the futures position is chosen, the manager possesses private information regarding the firm’s production capacity. Mandatory disclosure of the futures position in the financial statements allows the market to draw inferences over the manager’s information. These inferences affect the market’s pricing decision and in turn the manager’s hedging decision. The futures position taken is chosen not only to reduce price risk exposure but to signal some capacity level. In equilibrium, however, the market anticipates the manager’s strategy and is not fooled.Considering varying managerial preferences, we analyze three settings. In the basic setting speculation occurs whenever the manager prefers high market values in both periods. In the second setting we add transaction costs and find that speculation is less likely. Finally, we introduce uncertainty regarding the manager’s preferences. If the market needs to determine prices based on expected preferences, incentives to speculate are mitigated in equilibrium but still present.     

A note on the government budget restraint

In a recent article in this Journal, Christ presented a dynamic macroeconomic model which has the striking implication of instability under bond financing of budgetary deficits. In this paper, we show that the stability (and other fundamental) properties of Christ's model are closely related to the specification of the exogenous fiscal variables. This point is demonstrated through an analysis of Christ's model in which several definitions of government spending are taken as exogenous. As an alternative to this approach, we explore the implications of models in which alternative policy goals are specified as exogenous — goals such as a balanced or a zero gap between actual and potential output.     

Conflict variables in world simulations

World modellers have neglected social and political variables in their model building, basically because of problems of quantification. Instead they have treated these factors as exogenous, which has permitted a less rigorous approach to the relationship between their inputs and the real world. Here the author introduces two sociopolitical variables—conflict and centralisation—into Forrester's World 2 model, and Boyd's modified World 2, and compares the results of a series of computer runs with the results obtained from the original models. While the propositions linking these two variables to others in the World 2 model are largely hypothetical, the stability of the modified model suggests that these linkages are authentic—and that the study's findings concerning the effect of conflict upon the world system are valid.     

Can clients of economically dependent auditors benefit from voluntary audit firm rotation? An experiment with lenders

This study utilizes a nationwide random selection of 111 lenders in a 2?×?2 between-subjects experiment to determine whether the level of an auditor's economic dependence on a client and type of auditor rotation affect lenders’ independence and reliability perceptions and decisions to lend money to a potential borrower. Previous literature shows that financial statement users use client importance as a measure of audit quality when revenue streams are not equal across clients. This can negatively affect perceptions of independence and financial statement reliability. As United States regulators look for ways to improve audit quality under the current partner rotation mandate, this study explores whether an audited entity that voluntarily adopts a policy of firm rotation can mitigate the negative effects of the auditor's dependence on the client. Findings suggest that lenders view clients of economically dependent auditors (CEDA) as less independent from its auditor and perceive its financials as less reliable than clients without a dependent auditor (non-CEDA). Lenders are less likely to grant a loan to CEDA. However, under firm rotation, there is not only an increase in lenders’ perceptions of reliability of CEDA financials, but also no difference in perceptions of reliability of CEDA and non-CEDA financials.     

The international petroleum exchange model: Reference results and validation

The author describes the IPE model and compares its main results with the data for 1970–1978. The model's results are close to the actual consumer-import demand for those years. The model's forecasts of the future demand for oil imports, over the next 20 years, are considerably lower than the forecasts produced by some other studies.     

Attributions,cognitive processes and control systems

This paper reports two experiments which are designed to provide insights into how superiors and subordinates make perceptual or cognitive mappings from accounting signals to causal agents. The experiments focus on superiors' and subordinates' information seeking and causal attribution utilization to explain the subordinate's reported performance. Particular attention is given to (1) asymmetric causal attribution utilization by the superior and the subordinate and (2) the attribution mappings the two actors make when they receive ambiguous signals about the subordinate's reported performance.     

The government budget constraint and standard macrotheory

Christ, Blinder-Solow, Brunner-Meltzer and others have discussed the implications of deficits raising the public's stock of bonds or money. Among the major findings of this literature are that bond-financed deficits may raise income more than money-financed deficits, that the former may lead to instability, and that open market purchases ultimately lower nominal income. This paper shows that these seemingly revolutionary results (though not all of the results of this literature) follow simply from a textbook Keynesian or monetarist model. However, Blinder and Solow's conclusion that crowding-out cannot be complete is refuted.     

Search for information and portfolio selection

The paper examines the problem of how to allocate scarce resources between increasing the investor's knowledge, that is reducing his uncertainty, and the actual investment—that is a kind of an ex ante decision before the final parameters of the securities are known. Our model provides answers to questions of how the search for knowledge affects portfolio selection, to what extent additional information can improve estimates of securities' statistical parameters and how the benefits and costs of additional search alter the investor's efficient mean-variance portfolio set.     

An algorithmic approach to deriving the minimum-variance zero-beta portfolio

This paper examines the problem of deriving Black's (1972) minimum-variance zero-beta portfolio. Long's (1971) methods, used by Morgan (1975), are briefly mentioned. Then the complementary pivot algorithm of Lemke (1965), which has been shown to be capable of deriving the optimal solution to certain quadratic programming problems that are subject to a non-negativity constraint, is described. Finally, Lemke's algorithm is shown to be capable of deriving the minimum-variance zero-beta portfolio efficiently from samples of risky assets where both long and short positions are allowed by reformulating the problem so as to avoid the difficulties encountered by having a non-negatively constraint.     

Direct price controls as a source of instability in the interest rate/inflation rate relationship

We hypothesize that an efficient capital market is more concerned with effective inflation rates (which investors experience) than ‘official’ ones (which econometricians observe), and that direct consumer goods price controls are likely to result in disparity between the two. Consequently, direct price controls are also likely to affect the interest/measured inflation rate relationship. We ropose a dummy variable approach which enables us to explore empirically the effects of such controls on the interest/inflation rate relationship in the context of Dwyer's (1981) model. Using Euro rates and inflation rates of the respective countries we explore the impact of the control programmes imposed in the 1970's by governments of the united States, Canada and France. France.